3 key things for investors to watch in 2018

Should you be nervous about 2018?

2018 for global investment markets began with very strong returns, buoyed by a mood of optimism. In early February we saw a shift in market sentiment, with a sharp increase in volatility. So, what should we expect from the year ahead? Michael Winchester, Head of Investment Strategy, talks about 3 key things to watch in 2018.

How will shares perform?

What will happen if inflation rises?

Will the Australian property bubble finally burst?

1. Shares should continue to do well but expect volatility

In 2017, for the first time since the financial crisis began a decade ago, we saw all major economies showing strong growth. The consensus among economists seems to be that this momentum will continue into 2018.

Putting some numbers around this, the expectation is that global GDP will grow some 3.8% this year, with an average of 2.2% from developed markets such as the US, Europe and Australia, and 4.8% on average coming from the emerging world – the likes of China, Asia and Latin America.

Optimism around the economic outlook is reflected in investors’ expectations for earnings growth, which is 11% for international equities and 5.5% in Australia.

It’s worth bearing in mind that valuations are higher than average, and generally, when this is the case, future returns tend to be lower over the medium to long term.

There could be further pull back in share markets as the market adjusts to a world of higher interest rates.

Share markets have been rallying strongly over the past year in response to the positive environment, and in some markets such as the US, beyond what we believe to be fair value.

As a result, there could be further pull back in share markets as the market adjusts to a world of higher interest rates, which haven’t been seen for some time.

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2. If inflation rises, central banks will raise interest rates

Central banks around the world have been gradually reducing their stimulatory policy settings as their economies improved. The US Fed actually raised rates three times last year.

Most major central banks aim to keep prices stable. So the general absence of inflation in recent years has allowed them to keep interest rates very low.

Should inflation pressures rise sharply from here, central banks may need to raise interest rates more rapidly, which could see asset prices, including shares, falling.

The US economy is probably furthest advanced in the cycle and the Federal Reserve is expected to raise rates three more times in 2018, which would bring them close to a neutral policy setting.

During periods of strong economic growth and low unemployment, inflation tends to increase. So far, measures of inflation have remained soft, but should inflation pressures rise sharply from here, central banks may need to raise interest rates more rapidly, which could see asset prices, including shares, falling.

3. Australian housing market not likely to crash

If you believe the media, 2018 is either going to be the year the great Australian housing bubble finally bursts, or it’ll be another year of double digit growth. In our view it’s likely to be much more boring than that, which would be a pretty good outcome.

Supply of new homes has surged over the last few years, with growth mainly in apartments. This is more concentrated in cities such as Brisbane, Sydney and Melbourne, than others. Usually, prices soften whenever new supply comes to market and we suspect this will moderate future growth in prices.

That said, the other half of the equation is demand, and one thing we have in our favour in Australia is a healthy rate of population growth.

While there will probably be some pockets where prices fall, we think the likelihood of a crash is still fairly low.

Currently, population growth is around 1.6%, which is one of the highest in the developed world. While the new housing supply coming through today is in excess of what’s required based on estimates of demand, the current boom was preceded by a long period of undersupply, and we’re probably only now approaching the point where that’s been addressed.

So, while there will probably be some pockets where prices fall, we think the likelihood of a crash is still fairly low.

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